What approach to take to public finance devolution, local taxes and geographic fairness?

There is an imbalance in the UK economy, as commercial activity is heavily skewed towards London and the Southeast. Ross Campbell, ICAEW's Director of Public Sector, argues that increased devolution is desirable, but may not lead to stronger businesses in all regions. Considerable central government intervention will be required to ‘level’ the playing field.

Commercial activity is heavily skewed to London and the Southeast in the UK. The capital alone accounts for 22% of UK GDP despite accounting for only 12.5% of the UK population, and has a larger economy than Saudi Arabia. According to the Centre for Economic and Business Research, London makes a net contribution to the Exchequer of £34bn – essentially subsidising the rest of the UK, despite receiving disproportionate public spending on infrastructure and amenities.

This has not always been the case. The growth of a more service-based economy in recent decades – in particular financial and creative industries, which benefit from proximity – combined with the relative decline of manufacturing and extractive industries, has driven imbalance into the UK.

Here we consider: 

Geographic fairness

If ‘fairness’ in this context is that people in different geographic locations enjoy similar levels of wealth, then there are a number of questions to consider.

1. What drives the location of business?

Commercial activity is usually located where it is for good reasons. These can include:

• access to resources, infrastructure or workforce;
• proximity to other businesses engaged in similar activities; or
• other factors of production.

To encourage relocation the challenge it will be necessary to ensure that businesses have an enduring reason to be somewhere. Even for parts of the economy where a move can be compelled by government, such as the public sector, this can sometimes misfire. For example, when the Office for National Statistics moved to Newport from London a significant proportion of staff resigned and refused to relocate.

The best way to encourage businesses to locate somewhere and stay in that location is to create desirable factors. These factors will differ between businesses. For some it will be access to skills, raw materials or components, while for others access to their markets. For other organisations a tax break may be enough incentive to move, although that might not tie business to a location beyond the period for which it is offered.

One emerging trend is the gathering of related industries in hubs. For example, the biotechnology industry in Cambridge. A policy of reinforcing this type of success may require less public money than attempting to transplant industries or create them from scratch 

2. It is not likely to be practicable, affordable or desirable to support all industries in all regions.

This leads to the question of the criteria used to decide what locations and which industries to support. Policies of creating national champions have not always had the desired results. Furthermore, as the government has discovered with the defence industry, managing the relationship with a behemoth which you have created, can cause problems all of its own, if it deploys local political leverage to pursue its own objectives.

The exact question of how and how much to support businesses is a complex matter which I will not explore here. Suffice to say that governments in many countries have at times propped up failing and uncompetitive industries for electoral advantage. Government needs to first ensure it encourages industries that will grow and have enduring benefit, and second that it doesn't distort the industry and make it less efficient and unsustainable.

3. Are there wider factors that need to be taken into account?

The technological revolution currently under way is already having a significant impact on business. In many ways the full impact of automation, machine learning and the ability to process vast amounts of data is only just beginning to be felt and will have profound impacts on business location.

It is only going to get easier for many businesses to have less of a physical footprint or to choose which jurisdiction to locate in. Human participation in vast swathes of business activity, including some professional services may well almost disappear.

Anything involving a routine process has the potential to be automated. Transport, logistics and warehousing are already well on the way to becoming so. Other technologies such as 3D printing may well transform manufacturing both in terms of content and location beyond recognition. Why have a factory at a fixed location when a 3D printer can be set up wherever a product is needed?

Local taxation

If local services are to be delivered through local taxation and local people have a say in the nature and extent of those taxes, there has to be something to tax. The questions set out above with respect to geography are essentially questions of national policy.

The difficulty in the UK of moving to a system of local tax raising is that while there is a significant disparity in wealth, incomes and industrial activity between regions. There is a lack of a strong correlation between infrastructure and investment needs of different regions and their potential taxable revenues on the other. It might make matters worse in many parts of the UK if the balance of taxation between central and local government was shifted to local government without a corresponding rebalancing of economic activities between regions. 

Another practical issue in a country with small land mass such as the UK, where different administrative regions are close to each other, is that some taxes will be easier to avoid. This is especially true for businesses and individuals that are not tied to specific locations and is already the case with business rates. While a local corporation tax or income tax could be introduced there would still be scope for jurisdiction shopping that would favour those locales who could either offer lower rates, or better amenities.

Taxes that are not tied to a physical presence in a location are intrinsically not local and could only be raised by central government. Sales taxes are sometimes mooted, but the challenge of administering a differential sales tax based on location, are likely to include how to capture what sales have actually taken place in a jurisdiction. While this may be practical at the level of countries, it may be harder at the level of counties.

If it is advantageous, people may end up conducting their internet purchases from a different location to the one they are registered in. Or as seen with the poll tax, be a disincentive to registration. It is not uncommon in the US, a far larger place than the UK, for people to cross into a different state with lower taxes to make significant purchases.

This brings us back to the need for specific locations to be made attractive to business. A necessary precursor is the creation of incentives for industry to locate to regions. Whether these incentives take the form of grants, tax reliefs or access to things businesses want, they must exist to attract business. This in turn will probably require funding, which for the areas that do not already have large business communities, will have to come from central government if local taxes are not to be raised disproportionately.

Public finance devolution

In practice, in a small and highly integrated country like the UK, the delivery of government services and amenities does not always neatly divide up along county or even regional lines. As a consequence, the UK has a hybrid system, blending high levels of central funding with limited local taxation and with the consequent blurring of the ultimate accountability for local services.

In an ideal devolved situation, there would be clear demarcation between the things provided by central government out of central taxes and by local government out of local taxes. With clear accountability to the electorate for both. Local people could make decisions about the level of local services they wished to receive and the corresponding amount of tax they wished to pay. 

While there will always be questions about the size of the administrative unit that is considered ‘local’, a balance can usually be struck between having sufficient scale to be efficient and sufficient proximity to its electorate to be seen to have legitimacy.

We conclude that increased devolution of public financial management is desirable. However, it will not necessarily lead to stronger businesses in all the regions and rebalance the UK economy away from London. It might for some regions, but for others considerable central government intervention in the form of fiscal transfers and national investment in regional infrastructure will still be required to level the playing field. This will be money raised from central taxation and resources accountable to the national electorate, so will, of necessity, limit the scope for devolution.